factors are converging and pulling at the ordinary currency in
different directions.
While usually, political turmoil would hurt the EUR against the USD
and looks to have dented the EUR to start the week, the resulting
higher oil prices can really benefit the EUR once the unease and
investor sentiment around the pressing circumstances dies down.
The reason being that higher oil prices will feed through to higher
inflation and will support more talk of higher interest rates as the
ECB acts to counter the inflationary impact of higher oil. While ECB
President Trichet tried to temper expectations about rate hikes only a
week or so ago, suggesting that the market had priced in the ECB
moving earlier than may be warranted, we had that sentiment knocked
back on comments from Lorenzo Bini Smaghi, who has spent the last few
days warning of the likely permanent rise in food prices and the need
to take a preemptive strike against inflation. Therefore, higher oil
prices will contribute to higher commodity and food prices as it makes
it more expensive to ship goods around.
The speculation around ECB rate hikes was also helped by very strong
data in Germany where the IFO Business Climate index rose to a new
all-time high this month (111.2 from 110.3), and the preliminary
version of the Manufacturing (up to 59.0 from 57.3) and Air force
(57.2 from 55.9) PMI's came in much higher than anticipated.
As fears of higher inflation rise, they may outweigh the continued
concerns about the sovereign debt crisis. If that continues to be the
market's main focus then it will expect the ECB to concentrate on
keeping price pressures in check rather than curbing funding costs for
the peripheral debtors that still remain at risk. We saw the theme of
interest rate expectations dominate the past few weeks of trading in
our major currency pairs as traders try and price in which central
bank will bring to somebody's attention rates when and by how much.
On the other hand, we do have some new fissures in the sovereign debt
crisis, and focus may once again turn to the problems there, keeping
the EUR pressured in the near term. Bond yields in Portugal continue
to rise, with the 5-year bond yield now climbing above the
expressively vital 7% level. Last week we learned that EU member
states are pressuring Portugal to take a bailout, as the writing seems
to be on the wall that they will not be able to sustain such high
borrowing costs much longer.
While a Portuguese bail-out may be a foregone conclusion to the
markets, such a development would still rattle the EUR, though not as
much as the turmoil following Greece and then Ireland. That is because
the impact on the market of bailing out these smaller countries is
lessening. When Greece was bailout out the EUR fell to $1.20, but
dropped only slightly below $1.30 following the Ireland bailout. We
currently trade near 1.3650.
But, the conundrum comes when the market questions "who's next?"
and points their fingers at Spain. The current rescue fund the
European Financial Stability Facility (EFSF) is not huge enough to
rescue such a huge country as Spain.
Therefore its vital to see how politicians come together to either
increase the size or expand the scope of the EFSF though the expected
overhaul may not meet expectations.
With political turmoil in the Middle East and North Africa and
provocative moves by Iran vis-a-vie Israel, there is still uncertainty
about risk appetite which is likely to help boost the JPY and CHF at
the expense of the EUR.
But as I have laid out here, further than the small term, which major
theme wins out - sovereign debt concerns or interest rate
differentials? That will choose the fate of the EUR for the next few
weeks.
Source: ActionForex.Com
No comments:
Post a Comment